Morgan on Sesa Goa + Market Conviction

May 15, 2008

After Kotak Recommended a BUY on Sesa Goa, Morgan Stanley has also initiated coverage with a BUY recommendation. Sesa’s solid iron ore output growth. A change in sales mix from contract to spot market sales. The likelihood of above-consensus iron ore prices. These factors should support an EPS CAGR of 22% in F2008-10 for Sesa, which does not seem to be captured in the stock’s 7.5x P/E valuation.

Catalyst: Strong results in the next two quarters would be evidence of Sesa’s ability to grow volumes faster than Street expectations, and expand its sales in the spot market amid strong spot ore prices. Notably, these factors mark a change in the stock’s trends from just a year ago. Due to a lack of catalysts, the stock used to go into a slumber every year after the iron ore price contracts were concluded, but we do not expect that to be the case anymore.

Morgan Stanley iron ore price profile in line with our global team’s assumptions. EPS forecasts raised by 32% for F2009 and 21% for F2010 to Rs 523 and Rs 582 respectively. Target price of Rs 5,063 on the stock.

Investors lack conviction about the market:Trading activity and flows suggest that there is low conviction in the market. While foreign institutional investors are doing little in the cash markets, data from the derivative markets suggest heightened activity in index options and possible buying of volatility. On the other hand, domestic investors seem convinced this is a time to buy stocks. At the margin, a market bottom is unlikely to be created until retail investors panic.

There are three reasons why the lack of conviction among market participants does not surprise. The macro environment has worsened over the past month. A depreciating currency and rising commodity prices is a recipe for tighter monetary conditions and slower growth. Secondly, market timing indicators are not screaming a sell at us like they did in Jan-08, May-06 and Jan-04. Morgan believes that the indicators are unlikely to back up to those levels since fundamentals have undergone a distinct change and hence reckon that the recent bounce off the bottom is good enough to sell. Lastly, the earnings picture is sending mixed signals.

Conclusion: From a portfolio perspective, financials and industrials will likely underperform whereas consumer staples, healthcare, energy and telecoms will outperform.